Financing Financial Education

January 18, 2009

Early last fall a friend was telling me about his tentative plans to leave the government, where he promoted financial education, for the private sector, where he planned to consult with banks on how to promote financial literacy among their clientele. He was worried, though--financial education had never been high on the banking sector's to-do list.

My friend couldn't have asked for better timing. An underlying theme in most analyses of the financial crisis is the depressing lack of even basic financial know-how among the American public, particularly homebuyers and investors. As Yale economist Robert Schiller explains in a must-read column in today's New York Times, recent studies have shown a remarkable lack of knowledge about personal and market finances. One study of recent homebuyers is particularly shocking: "Many of the respondents could not even correctly ans even simple questions, like this one: What will a $300 item cost after it goes on a '50 percent off' sale?" The mind reels.

It's common today for progressive economists to use recent bubble markets as evidence that consumer behavior isn't rational, undercutting one of the basic assumptions behind free-market classical economics. But as Schiller notes, it's not simply that consumers are irrational; it's that particularly in complex markets, they simply don't understand what's going on, and they rely on faulty assumptions and inflated expectations, which to them seem perfectly rational, when making big purchases like homes and cars. And that's setting aside the ease with which financial illiteracy allows scammers and slick salesmen to take advantage of would-be buyers.

Schiller's solution is for the federal government to subsidize financial education and advice. To an extent it already is, through tax write-offs, but lower-income people, who really need this sort of help, typically don't itemize their taxes. So direct subsidies, a la Medicaid and Medicare, are the better approach. "Professional financial advice is now generally accessible only by the relatively wealth," Schiller concludes. "Giving the general public access to trained adivsers would be boon for the nation in this time of doubt and mistrust." And if it gives my friend steady work, all the better.